The 7Twelve Investment Strategy
What is 7Twelve?
7Twelve is a blueprint for financial advisors looking to build a well-diversified investment strategy with a single investment. Unlike a traditional two-asset 60-40 balanced fund, the 7Twelve balanced strategy uses multiple asset classes in an effort to enhance performance and/or reduce risk.
Our balanced strategy provides investors access to non-traditional assets such as real estate, commodities, and emerging markets.
Each investment asset adds an important dimension to the portfolio because of the low correlation and behavior between them.
The '7' of 7Twelve represents the suggested number of asset classes to include in your portfolio. The 'Twelve' represents the 12 underlying investments.
Why an Index-Based Diversified Portfolio?
Why index-based? Active managers may not always outperform their index-based benchmarks. Most investors are under-diversified. For example, they do not own commodities or real estate despite the fact that these two asset classes make up over 57% of all global investable assets. Holding these together with stocks, bonds, and cash in one inseparable portfolio helps make the world safe for non-traditional assets.
Additionally, Professors Brad M. Barber and Terrance Odean wrote, “Some investors fail to take advantage of the full benefits of diversification. Under-diversified investors might over-invest in company stock, local stocks, familiar stocks, and domestic companies. Doing so may make them feel safe, but it leaves them exposed to increased volatility in their investment returns.” Source: Handbook of the Economics of Finance, 2013.
In sum, the 7Twelve strategy seeks to provide breadth across seven core asset classes, and diversification depth within each separate fund in the portfolio.
Why 7 Asset Classes?
The 7Twelve strategy uses multiple asset classes to seek to enhance performance and reduce risk.
The traditional equation of two asset classes – U.S. stocks and U.S. bonds – may not add up to greater returns and less volatility.
The long-term success of the 7Twelve strategy may be the result of genuine diversification across these seven core asset classes.
So: 7Twelve is a diversification tool for the under-diversified.
The 12 Underlying Investments
The 7Twelve strategy uses multiple asset classes: equities, fixed-income, traditional assets, and non-traditional assets. The strategy looks to invest approximately 8.3% in each asset class.
There are two ways to invest: predict the market,
or equally-weight. Equal-weighting is the reality
that we cannot consistently pick winners.
Why Equally Weight a Portfolio?
If you could consistently pick winners it would be settled science that market-cap weighted portfolios outperform equally-weighted portfolios.
However, the opposite is often the case. Market-cap weighted indexes have historically underperformed equally-weighted portfolios. According to Morningstar, for the 25 years ended 2018, the S&P 500 Equal Weighted Index produced an average annual return of 10.33%, vs. a 9.74% average annual total return for the market-cap weighted S&P 500 Index.
The components of a market-cap weighted index are weighted according to their market capitalization: larger components
carry larger percentage weighting. In an equally-weighted portfolio, each security is owned in equal amounts. Market capitalization is the total dollar market value of a company’s outstanding shares.)
Equal-weighting puts one important decision for you and your clients on auto-pilot and frees up your time for the decisions over which you actually have control.
An equally-weighted portfolio may be effective in today’s turbulent times. “Equal weighting’s prospects improve when forecasting is difficult, when there are lots of investment choices and when the historical learning sample is limited. That more or less describes the profile of the capital markets.”
Building a Better Balanced Fund
7Twelve may be a natural alpha generator. How might you add alpha to a portfolio of large cap U.S. stocks?
Answer: add small cap U.S. stocks.
From 1997-2018, the average annual total returns were 7.97% for U.S. small caps, vs. 6.47% for U.S. large caps. How might you add alpha to U.S. bonds? Add non U.S. bonds: 4.96% vs. 4.56% annual returns respectively over the same period.
Or you could add real estate, which was the number one asset class among the major seven (U.S. and non U.S. stocks and bonds, cash, real estate, and commodities) for the same period. Or add TIPS to aggregate bonds. From 11/30/03 - 7/31/06, when the Fed Funds rate rose by 4.25%, TIPS outperformed aggregate bonds by 4.3% annualized. Or you could add commodities, which was the #1 asset of the seven assets ten times since 1970.
This is how you generate alpha with a beta fund. This is also why we do not “fire” an asset just because it had a bad year. Example: the commodities sector was the worst performer for 7Twelve strategy in 2014 and for the first quarter of 2015 - but the best performer for second quarter 2015.
Why Passive Management?
Passive has outperformed active over the short and long-terms.
According to Standard & Poor’s, 64.49% of large-cap fund managers under-performed their benchmark in 2018. Over 5- and 10-year periods ended 2018, 82.14% and 85.14%, respectively, of large-cap managers failed to deliver incremental returns over their benchmark.
Asset growth has followed returns: passive U.S. equity funds saw inflows of $220 billion in 2017; active U.S. funds lost $207 billion. In 2018, passive funds saw inflows of $207 billion, while active funds saw a $174 billion outflow. (Source: Morningstar.)
We are committed passive investors. We say no to an industry where the long-term is measured in weeks and months - rather than in decades.
As of December 2018: Percentage of Active U.S. Equity Funds Outperformed by Benchmarks
Source: SPIVA US Scorecard
7Twelve Advisors, LLC (“7Twelve”) is a registered investment advisor with the U.S. Securities and Exchange Commission. The information contained herein is for educational purposes only and is not to be considered investment advice nor a recommendation of any fund, product or investment. Information is obtained from third-party sources which are believed to be reliable, but have not been independently verified by 7Twelve. “7Twelve” is a trademark. 7Twelve™, 7Twelve Advisors, LLC, and all strategies, models, adaptations, and products created from said intellectual property are the sole ownership of Craig L. Israelsen, PhD, and/or 7Twelve Advisors, LLC.
The value of small or medium capitalization company stocks may be subject to more abrupt or erratic market movements than those of larger, established companies or the market averages in general. Real estate values rise and fall in response to a variety of factors, including local, regional and national economic conditions, interest rates and tax considerations. The value of the strategy’s investments in bonds and other fixed income securities will fluctuate with changes in interest rates. Security issuers might not make payments on debt securities held by the strategy, resulting in losses. Foreign investing involves risks not typically associated with U.S. investments, including adverse fluctuations in foreign currency values, adverse political, social and economic developments, less liquidity, greater volatility, less developed or less efficient trading markets, political instability and differing auditing and legal standards. Countries with emerging markets also may have relatively unstable governments, social and legal systems that do not protect shareholders, economies based on only a few industries, and securities markets that trade a small number of issues. Investing in the commodities markets through commodity-linked ETFs will subject the strategy to potentially greater volatility than traditional securities. Commodity prices are influenced by unfavorable weather, animal and plant disease, geologic and environmental factors as well as changes in government regulation such as tariffs, embargoes or production restrictions. The strategy’s exposure to companies primarily engaged in the natural resource markets may subject the strategy to greater volatility than the securities market as a whole.
Increases in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable. The cost of investing in the strategy will be higher than the cost of investing directly in ETFs and may be higher than other mutual funds that invest directly in stocks and bonds.
“The 7Twelve Strategy” is back-tested by equal-weighting Twelve underlying indexes, funds, and ETFs which represent the asset classes. In as much as TIPS were first traded as a security in 1998 (first full year), the only way one can model the strategy longer term (back to 1970) is to compare with the "7 Asset" strategy which is composed of US and non US Bonds and Stocks, Real Estate (REITS), Commodities, and Cash. There has been a high correlation between the returns of the 7Twelve strategy and the 7 asset strategy, but there is no guarantee that this will continue. Indexes are not investable. No fund or securities product returns are mentioned or implied. Past performance is no guarantee of future returns.